Can credit builder loans hurt my credit score?

Like other financial products, if you miss a payment that could have a negative impact on your credit score. While the loan is designed to help, a missed payment could hurt your score. While not a credit builder loan, this is why Perpay has built-in features, like automatic payments from your paycheck, to help you stay on track and avoid the possibility of missed payments.

Is a credit builder loan an installment loan or a revolving loan?

A credit builder loan is an installment loan. This means you borrow a set amount of money and have a fixed number of scheduled payments to pay it back. A revolving loan, like a credit card, lets you borrow repeatedly up to a limit.

Do I get the interest I pay back at the end of the loan?

It depends on the lender. Some lenders may return a portion of the interest you paid or the interest earned on the locked-up savings account balance when the loan is paid off.³ However, others may keep all the interest and fees as the cost of the loan. It’s important to check the loan terms carefully.

How Credit Builder Loans Work: A Simple Guide — Perpay

If you're looking for different ways to build credit, you might have heard of a credit builder loan.

This guide is part of our series on Tools to Build Credit, which covers different strategies for building your credit. We're going to break down credit builder loans so you can decide if it's the right choice for your financial journey.

How Credit Builder Loans Work

A credit builder loan is a type of installment loan designed specifically to help you build a positive credit history.¹ It’s often used by people who have little to no credit or who are working to recover from past financial trouble.

The biggest thing to understand is that it works backwards from a standard loan:

You don’t get the money right away. With a regular loan, you get a lump sum of cash upfront. With a credit builder loan, the lender deposits the loan amount into a locked savings account or a Certificate of Deposit (CD) that you cannot access right away.²
You pay it off first. You make fixed, regular monthly payments to the lender over the loan term.¹ Loan amounts are typically small, often ranging from $300 to $1,000.³ Terms generally last anywhere from 6 to 24 months.⁴
They report your payments. The lender reports your on-time payments to the major credit bureaus (Experian, Equifax, and TransUnion).² This is how your credit score begins to grow!
You get the money at the end. Once you have made all the payments, the lender unlocks the account, and you get the money back (minus any interest or fees you paid).¹

What Are the Costs and Best Uses for This Type of Loan?

Credit builder loans are not free. They may come with interest rates and sometimes fees.

Interest Rates and Fees: You will typically pay interest on the loan, but some lenders may give you back a portion of the interest or the interest earned on the savings account at the end.¹ Interest rates vary a lot, sometimes ranging from a low single-digit percentage up to a higher double-digit percentage.⁵
Who Offers Them: You can often find these loans at local credit unions, community banks, and some online lenders.³
Who This Is For: This kind of loan can be a good fit if your main goal is to build a reliable payment history and create a small savings cushion, especially if you can manage without access to those funds for a while. These funds will not be available for emergencies until the end of the loan term.

Why This Method Helps Your Credit Score

Credit builder loans are effective because they address two major factors in your credit score calculation:

Payment History (41% of your score): By making consistent, on-time payments, you are working towards a reliable track record that lenders want to see. This history could have a significant impact on your credit score.⁶ It's important to know that if you miss a payment, it will most likely be reported to the credit bureaus and could unfortunately hurt your credit score instead of helping it.³
Depth of Credit (20% of your score): This factor looks at your account age and the variety of credit types you use. This type of loan is an installment account (fixed payments over a set time). If you already have a revolving account (like a credit card), adding an installment loan helps show you can handle both types of credit, which can have a positive impact on your credit score.⁶

Key Questions to Ask Before Applying

Before you sign up for a credit builder loan, it's a good idea to ask your lender these key questions so you have all the facts upfront:

Which credit bureaus do you report to?
What is the Annual Percentage Rate (APR)?
Are there any application or closing fees?
What is the minimum term length?

A Different Path: Building Credit with Perpay

We know that not every tool works for everyone. Perpay offers a different kind of solution if you’re looking for other ways to build credit besides a credit builder loan.

Perpay+: Building Credit, Simplified

If you’re looking for an affordable way to build credit, Perpay+ is the feature that helps you do it.

Credit Building: Get up to a $1,000 spending limit reported to all 3 major credit bureaus for only $5/month.
Easy Payments: Make automatic payments through your paycheck. For example, if you’re paid twice a month, you would simply set up $2.50 to be sent to Perpay from each paycheck. This paycheck-based payment system helps you stay on track.
Apply in 30 seconds: There is no hard credit check with the major credit bureaus when applying for Perpay.*

Perpay Marketplace: Take Your Credit to the Next Level

Build credit while shopping for the things you need. Here’s how it works:

Shop Top Brands: Use your spending limit to shop for electronics, home goods, apparel, and more.**
Pay Over Time: Pay over time in installments through automatic payments directly from your paycheck.
No Interest, No Fees: Shop stress-free knowing there aren’t any surprise fees.
Level Up Your Credit Building: Your on-time payment history will be reported to all 3 major credit bureaus – adding healthy credit factors to your credit report. Users see their score increase by an average of 32 points within the first 3 months.***

Perpay is proud to be a Certified B Corporation, meaning we meet high standards for accountability and transparency with our members.

Conclusion: Weighing the Options

A credit builder loan is a helpful tool for creating an initial, positive credit footprint. It forces you to save money while building credit history.

However, if locking up your money for a year or more would create a challenge, there are other tools that might be a better fit for your financial situation.

Frequently Asked Questions (FAQ)

Can credit builder loans hurt my credit score? Like other financial products, if you miss a payment that could have a negative impact on your credit score. While the loan is designed to help, a missed payment could hurt your score.⁴ While not a credit builder loan, this is why Perpay has built-in features, like automatic payments from your paycheck, to help you stay on track and avoid the possibility of missed payments.
Is a credit builder loan an installment loan or a revolving loan? A credit builder loan is an installment loan.¹ This means you borrow a set amount of money and have a fixed number of scheduled payments to pay it back. A revolving loan, like a credit card, lets you borrow repeatedly up to a limit.
Do I get the interest I pay back at the end of the loan? It depends on the lender. Some lenders may return a portion of the interest you paid or the interest earned on the locked-up savings account balance when the loan is paid off.³ However, others may keep all the interest and fees as the cost of the loan. It’s important to check the loan terms carefully.

Find your path to financial progress. Learn more about how Perpay can help you build credit today.

Sources:

^*Applying for a Perpay account will not affect your FICO® or Vantage® score. However, we may obtain information from Clarity which may affect your credit profile with this alternative credit bureau.

^**Access to the Perpay Marketplace is offered by Perpay, Inc., and is only available to eligible consumers residing in the United States. The Perpay Marketplace is subject to credit approval. See our Terms & Conditions for more information.

^***The credit score (VantageScore 4.0) increase of 32 points is based on the average of approximately 80,000 Perpay+ customers with a baseline credit score of 550 or below during the first three months of reporting. The same group observed an average credit score increase of 55 points over a two-year period if they maintained on time payments both on and off Perpay’s platform. Credit score improvement is not guaranteed, and individual results may vary based on a number of factors. Perpay will report your transactions to Experian®, Equifax®, and TransUnion®. On-time payment history can have a positive impact on your credit score. Late payments may result in payment reporting to credit bureaus that may negatively impact your credit score. This product will not remove negative credit history from your credit report. Perpay+ is only available to eligible Marketplace account holders. Fees apply. See the Perpay Terms and Conditions for more details.

Perpay does not provide financial, legal, or regulatory advice. The content is for general informational purposes only. Any views expressed are those of Perpay, not its partner institutions. We do not endorse or guarantee the accuracy of any linked third-party information. Links to Perpay products are advertisements. All external brand names belong to their respective owners.

How Credit Builder Loans Work: A Simple Guide